Archive for the ‘Government Interventions’ Category

In this final piece on Government Interventions, I want to highlight some of the many ways that governments interfere in the free market. Regulations, taxes, tariffs, subsidies, and bailouts are all governmental actions that have a distorting effect on the market and that cause producers and consumers to act differently than they would have without those distorting influences. Let’s start with regulations.

Whether or not a regulation is perceived by the public to be good or bad overall, it will necessarily change the behavior of the regulated company or industry. Costs of complying with the regulation will tend to reduce the profits of the regulated company, resulting in unemployment for the least productive workers in the company or higher prices for the consumer or, most likely, both. I have heard industry-wide regulations justified on the grounds that they “create a level playing-field” for the producers in the regulated industry. But this is simply not true. A large company with a big share of the market already has an advantage over a smaller company in an industry, and so a regulation affecting them both will obviously be more harmful to the small company than to the large. In fact, many if not most regulations are actively endorsed by larger companies because they know that small competitors will be harmed more than they will, which may help weed out some of that competition and thus further increase their market share. Over time, the cumulative effect of regulations will be to concentrate market share in a few large companies within the regulated industry because the compliance costs are simply too great for smaller companies to remain profitable or even to get started in the first place. Examples in today’s world would be the oil industry and the radio industry, where small companies tend to struggle and new entrants to the market are rare these days.

I talked about the distorting effects of taxes in Part 1, so I won’t go into that again much here. I only want to add that not only do taxes take money from taxpayers to spend on things they wouldn’t have purchased, but corporate taxes and sales taxes also raise the price of the things the taxpayers do purchase.

Tariffs are a subset of taxes, specifically a tax on goods imported into (and sometimes on goods exported from) a given country. The purpose of the tariff is generally to raise the prices of foreign goods relative to domestic goods. In other words, a tariff tries to keep the people’s money at home, rather than allowing them to spend it on what they want from wherever they want.

A subsidy is money granted by the government to a company, justified as an effort to “assist an enterprise deemed advantageous to the public.” A bailout is just a particularly large one-time subsidy, assisting the enterprise in question by preventing it from going bankrupt. I hope it’s obvious that the government giving money to any company creates a distortion of the market, but here are a few reasons why, just in case it’s not. For one thing, the company can now charge less for its products or services than it would have because the government is making up the difference in revenue. So subsidized companies will have that advantage over unsubsidized ones. However, this also allows inefficiencies in the company to go “unpunished” by the market, since the incentive to economize is diminished by the free money from the government. For the consumer, the net result tends to be lower quality without much lower price.

There are literally hundreds, maybe thousands, of specific examples of governmental market distortions that could be cited, but I just wanted to convey some of the broad categories to illustrate the economic effects of government actions. Many times regulations, taxes, and subsidies are discussed in the news in terms of fairness or need, but the economic effects are almost never mentioned or else are glossed over. My personal view is that, if a government at any level is thinking of adopting a policy, it should not be afraid to consider the effects that the policy will have on the economy. It should consider the probable costs as well as the possible benefits. And once it has considered this, for the reasons mentioned above and in the previous article, it should expect that it has underestimated those costs.

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In the last article, I was discussing the idea that taxation causes the economy to be less efficient as people are prevented from using their money only for goods or services which they value and instead are forced to use it for services which some of them won’t value. Another aspect of this inefficiency, however, is built-in to the government-provided services themselves. There are two facets of this built-in inefficiency: the inability to gauge customer satisfaction and what might be termed a disincentive to economize.

In a free market, companies have to provide their customers with a satisfying experience or risk losing those customers to a competitor. When enough customers take their business elsewhere, the company will lose money. The easiest way for a company to know that it is satisfying its customers is the fact that it’s making a profit. Profits tell a company that it is running efficiently and making its customers happy. Losses tell a company that it is not running efficiently and/or that its potential customers are not happy.

Government has no “profit-and-loss test” like this. For the most part, it faces no competition for the services it provides. Furthermore, all government services are either paid for entirely by money collected in taxes, or else, in the cases where users pay fees, it is understood that tax money will be used to bail out departments that are losing money. Therefore, the government cannot know whether and to what extent it is providing a service that is valued, and it cannot tell whether and to what extent it is providing that service efficiently and in a way that is satisfying its customers.

Another facet of this inefficiency has to do with incentives. In a private company that depends on making a profit to stay in business, cost-cutting is typically encouraged and rewarded. In government bureaucracies, because there’s no profit and loss test to tell if a department is running efficiently, each department’s budget is based on what they spent the year before. If there is any money left over at the end of one year, it is assumed that they don’t need as much the next, and so their budget may be cut. If the department spends its entire budget for the year, it is easier for the manager to justify receiving the same amount or more for the next year. This disincentive results in a tendency for government to continually spend more and more.

Note that these problems exist independently of whether a given department or agency is making any progress at all towards its mission. No matter how bloated or ineffective a government department already is, the government has no way to make it more efficient and no financial incentive to do so. In part three, I’ll take a look at ways that government, besides being inefficient in and of itself, actually hinders the free market from being as efficient as it could be.

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Now that we’ve seen some of the basics involved in how the economy works, I want to take a look at government interventions into the economy. This topic has many aspects, so I’m going to tackle it in three parts. This first part deals with taxes.

It turns out that everything that government does is an intervention into the economy because all of the money used to pay for government comes from taxes; even borrowed money will later have to be repaid through taxes. Taxation is an intervention because it removes money from the free market and puts it into the coerced market. In effect, taxpayers are forced to buy some services whether or not they need them or even want them. Some taxpayers will use those services. Others will not use the services but support their use by other people and would have voluntarily paid for other people to use them. Still others will neither use nor support those services. But the taxpayer’s money goes to the services all the same, regardless of the category into which the taxpayer falls. This is what I mean by the coerced market.

Do you see why this would not be the most efficient use of the society’s resources? If all transactions in an economy are voluntary, the society as a whole is constantly becoming better and better off as all of its people are becoming better and better off. This is because all voluntary transactions necessarily leave all parties to the exchange better off than they were before; otherwise the exchange would not take place. If you have a choice of keeping your money or buying a service like house cleaning, you choose to buy the service only if you believe it to be of greater value than keeping the money. If each person has no choice in the matter, as when their money is taken to pay for a service whether or not they want it, then it necessarily follows that some people will feel better off and others will feel worse off, but there is no way of knowing whether society as a whole is better or worse off.

The very fact that the money used to pay for government services is taken rather than earned means that the economy is distorted from running at its optimal efficiency. But there are other problems as well. In the next article, I’ll discuss how it is that government cannot know whether it is using its own resources efficiently in efforts to achieve its stated goals.